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« Here is a method for measuring the profit potential 
of alternative product-market strategies, starting with a 
forecast of trends and contingencies and then work¬ 
ing toward company needs and long-run objectives. 


for Diversification 

By H. Igor Ansojf 

The Red Queen said, “Now, here, it takes all 
the running you can do to keep in the same place. 
If you want to get somewhere else, you must run 
at least twice as fast as that!” 1 

So it is in the American economy. Just to re¬ 
tain its relative position, a business firm must 
go through continuous growth and change. To 
improve its position, it must grow and change at 
least “twice as fast as that.” 

According to a recent survey of the ioo larg¬ 
est United States corporations from 1909 to 
1948, few companies that have stuck to their 
traditional products and methods have grown in 
stature. The report concludes: “There is no 
reason to believe that those now at the top will 
stay there except as they keep abreast in the 
race of innovation and competition.” 2 

There are four basic growth alternatives open 
to a business. It can grow through increased 
market penetration, through market develop¬ 
ment, through product development, or through 

A company which accepts diversification as 
a part of its planned approach to growth under¬ 
takes the task of continually weighing and com¬ 
paring the advantages of these four alternatives, 
selecting first one combination and then another, 
depending on the particular circumstances in 
long-range development planning. 

While they are an integral part of the over- 

1 Lewis J. Carroll, Through the Looking-Glass (New 
York, The Heritage Press, 1941). P- 41* 

2 A. D. H. Kaplan, Big Enterprise in a Competitive 
System. (Washington, The Brookings Institution, 1954), 

p. 142. 

all growth pattern, diversification decisions pre¬ 
sent certain unique problems. Much more than 
other growth alternatives, they require a break 
with past patterns and traditions of a company 
and an entry onto new and uncharted paths. 

Accordingly, one of the aims of this article 
is to relate diversification to the over-all growth 
perspectives of management, establish reasons 
which may lead a company to prefer diversifica¬ 
tion to other growth alternatives, and trace a re¬ 
lationship between over-all growth objectives and 
special diversification objectives. This will pro¬ 
vide us with a partly qualitative, partly quanti¬ 
tative method for selecting diversification strate¬ 
gies which are best suited to long-term growth of 
a company. We can use qualitative criteria to 
reduce the total number of possible strategies to 
the most promising few, and then apply a return 
on investment measure to narrow the choice of 
plans still further. 

Product-Market Alternatives 

The term “diversification” is usually associ¬ 
ated with a change in the characteristics of the 
company’s product line and/or market, in con¬ 
trast to market penetration, market development, 
and product development, which represent other 
types of change in product-market structure. 
Since these terms are frequently used inter¬ 
changeably, we can avoid later confusion by de¬ 
fining each as a special kind of product-market 
strategy. To begin with the basic concepts: 

C The product line of a manufacturing company 
refers both to (a) the physical characteristics of 
the individual products (for example, size, weight, 


114 Harvard Business Review 

materials, tolerances) and to (b) the performance 
characteristics of the products (for example, an air¬ 
plane’s speed, range, altitude, payload). 

€ In thinking of the market for a product we 
can borrow a concept commonly used by the mili¬ 
tary — the concept of a mission. A product 
mission is a description of the job which the 
product is intended to perform. For instance, one 
of the missions of the Lockheed Aircraft Corpora¬ 
tion is commercial air transportation of passengers; 
another is provision of airborne early warning for 
the Air Defense Command; a third is performance 
of air-to-air combat. 

For our purposes, the concept of a mission is 
more useful in describing market alternatives than 
would be the concept of a “customer,” since a 
customer usually has many different missions, each 
requiring a different product. The Air Defense 
Command, for example, needs different kinds of 
warning systems. Also, the product mission con¬ 
cept helps management to set up the problems in 
such a way that it can better evaluate the per¬ 
formance of competing products. 

« A product-market strategy, accordingly, is a 
joint statement of a product line and the corre¬ 
sponding set of missions which the products are 
designed to fulfill. In shorthand form (see Exhibit 
i), if we let n represent the product line and ^ 
the corresponding set of missions, then the pair 
of it and /a is a product-market strategy. 

With these concepts in mind let us turn now 
to the four different types of product-market 
strategy shown in Exhibit i: 

€ Market penetration is an effort to increase 
company sales without departing from an original 
product-market strategy. The company seeks to 
improve business performance either by increasing 
the volume of sales to its present customers or by 
finding new customers for present products. 

C Market development is a strategy in which 
the company attempts to adapt its present product 
line (generally with some modification in the prod¬ 
uct characteristics) to new missions. An airplane 

Exhibit i. Product-market strategies for 

business growth alternatives 




M 2 * 








7T 2 

1- 1- 

O z 

rD m-i 






company which adapts and sells its passenger trans¬ 
port for the mission of cargo transportation is an 
example of this strategy. 

C A product development strategy, on the other 
hand, retains the present mission and develops 
products that have new and different characteris¬ 
tics such as will improve the performance of the 

C Diversification is the final alternative. It calls 
for a simultaneous departure from the present 
product line and the present market structure. 

Each of the above strategies describes a dis¬ 
tinct path which a business can take toward 
future growth. However, it must be emphasized 
that in most actual situations a business would 
follow several of these paths at the same time. 
As a matter of fact, a simultaneous pursuit of 
market penetration, market development, and 
product development is usually a sign of a pro¬ 
gressive, well-run business and may be essential 
to survival in the face of economic competition. 

The diversification strategy stands apart from 
the other three. While the latter are usually 
followed with the same technical, financial, and 
merchandising resources which are used for the 
original product line, diversification generally 
requires new skills, new techniques, and new 
facilities. As a result, it almost invariably leads 
to physical and organizational changes in the 
structure of the business which represent a dis¬ 
tinct break with past business experience. 

Forecasting Growth 

A study of business literature and of com¬ 
pany histories reveals many different reasons for 
diversification. Companies diversify to compen¬ 
sate for technological obsolescence, to distribute 
risk, to utilize excess productive capacity, to re¬ 
invest earnings, to obtain top management, and 
so forth. In deciding whether to diversify, man¬ 
agement should carefully analyze its future 
growth prospects. It should think of market 
penetration, market development, and product 
development as parts of its over-all product strat¬ 
egy and ask whether this strategy should be 
broadened to include diversification. 

Long-Term Trends 

A standard method of analyzing future com¬ 
pany growth prospects is to use long-range sales 
forecasts. Preparation of such forecasts involves 
simultaneous consideration of a number of major 

• General economic trends. 

• Political and international trends. 

• Trends peculiar to the industry. (For ex¬ 
ample, forecasts prepared in the airplane in¬ 
dustry must take account of such possibilities 
as a changeover from manned aircraft to 
missiles, changes in the government “mobili¬ 
zation base” concept with all that would mean 
for the aircraft industry, and rising expendi¬ 
tures required for research and development.) 

• Estimates of the firm’s competitive strength 
relative to other members of the industry. 

• Estimates of improvements in the company 
performance which can he achieved through 
market penetration, market development, and 
product development. 

• Trends in manufacturing costs. 

Such forecasts usually assume that company 
management will be aggressive and that manage¬ 
ment policies will take full advantage of the op¬ 
portunities offered by the different trends. They 
are, in other words, estimates of the best possi¬ 
ble results the business can hope to achieve short 
of diversification. 

Different patterns of forecasted growth are 
shown in Exhibit ii, with hypothetical growth 
curves for the national economy (GNP) and the 
company’s industry added for purposes of com¬ 
parison. One of the curves illustrates a sales 
curve which declines with time. This may be 
the result of an expected contraction of demand, 
the obsolescence of manufacturing techniques, 
emergence of new products better suited to the 
mission to which the company caters, or other 
changes. Another typical pattern, frequently 
caused by seasonal variations in demand, is one 
of cyclic sales activity. Less apparent, but more 
important, are slower cyclic changes, such as 
trends in construction or the peace-war variation 
in demand in the aircraft industry. 

If the most optimistic sales estimates which 
can be attained short of diversification fall in 
either of the preceding cases, diversification is 
strongly indicated. However, a company may 
choose to diversify even if its prospects do, on 
the whole, appear favorable. This is illustrated 
by the “slow growth curve.” As drawn in Ex¬ 
hibit ii, the curve indicates rising sales which, 
in fact, grow faster than the economy as a whole. 
Nevertheless, the particular company may be¬ 
long to one of the so-called “growth industries” 
which as a whole is surging ahead. Such a com¬ 
pany may diversify because it feels that its pro- 

Strategies for Diversification 115 
Exhibit n. Trend forecasts 

spective growth rate is unsatisfactory in com¬ 
parison to the industry growth rate. 

Making trend forecasts is far from a precise 
science. The characteristics of the basic envi¬ 
ronmental trends, as well as the effect of these 
trends on the industry, are always uncertain. 
Furthermore, the ability of a particular business 
organization to perform in the new environment 
is very difficult to assess. Consequently, any 
realistic company forecast should include sev¬ 
eral different trend forecasts, each with an ex¬ 
plicitly or implicitly assigned probability. As 
an alternative, the company’s growth trend fore¬ 
cast may be represented by a widening spread 
between two extremes, similar to that shown 
for GNP in Exhibit ii. 


In addition to trends, another class of events 
may make diversification desirable. These are 
certain environmental conditions which, if they 
occur, will have a great effect on sales; however, 
we cannot predict their occurrence with cer¬ 
tainty. To illustrate such “contingent” events, 
an aircraft company might foresee these possi¬ 
bilities that would upset its trend forecasts: 

• A major technological “breakthrough” whose 
characteristics can be foreseen but whose tim¬ 
ing cannot at present be determined, such as 
the discovery of a new manufacturing process 
for high-strength, thermally resistant aircraft 

• An economic recession which would lead to 
loss of orders for commercial aircraft and 
would change the pattern of spending for 
military aircraft. 

• A major economic depression. 

• A limited war which would sharply increase 
the demand for air industry products. 

116 Harvard Business Review 

• A sudden cessation of the cold war, a currently 
popular hope which has waxed and waned 
with changes in Soviet behavior. 

The two types of sales forecast are illustrated 
in Exhibit iii for a hypothetical company. Sales 
curves S 4 and S 2 represent a spread of trend 
forecasts; and S 3 and S 4 , two contingent fore¬ 
casts for the same event. The difference be¬ 
tween the two types, both in starting time and 
effect on sales, lies in the degree of uncertainty 
associated with each. 

In the case of trend forecasts we can trace a 
crude time history of sales based on events which 
we fully expect to happen. Any uncertainty 
arises from not knowing exactly when they will 
take place and how they will influence business. 
In the case of contingency forecasts, we can 
again trace a crude time history, but our uncer¬ 
tainty is greater. We lack precise knowledge 
of not only when the event will occur but also 
whether it will occur. In going from a trend 
to a contingency forecast, we advance, so to 
speak, one notch up the scale of ignorance. 

In considering the relative weight we should 
give to contingent events in diversification plan¬ 
ning, we must consider not only the magnitude 
of their effect on sales, but also the relative prob¬ 
ability of their occurrence. For example, if a 
severe economic depression were to occur, its 
effect on many industries would be devastating. 
Many companies feel safe in neglecting it in 
their planning, however, because they feel that 
the likelihood of a deep depression is very small, 
at least for the near future. 

It is a common business practice to put pri¬ 
mary emphasis on trend forecasts; in fact, in 
many cases businessmen devote their long-range 
planning exclusively to these forecasts. They 
usually view a possible catastrophe as “some¬ 
thing one cannot plan for” or as a second-order 

Exhibit iii. A hypothetical company fore¬ 

cast — no diversification 

correction to be applied only after the trends 
have been taken into account. The emphasis is 
on planning for growth, and planning for con¬ 
tingencies is viewed as an “insurance policy” 
against reversals. 

People familiar with planning problems in 
the military establishment will note here an in¬ 
teresting difference between military and busi¬ 
ness attitudes. While business planning em¬ 
phasizes trends, military planning emphasizes 
contingencies. To use a crude analogy, a busi¬ 
ness planner is concerned with planning for 
continuous, successful, day-after-day operation 
of a supermarket. If he is progressive, he also 
buys an insurance policy against fire, but he 
spends relatively little time in planning for fires. 
The military is more like the fire engine com¬ 
pany; the fire is the thing. Day-to-day opera¬ 
tions are of interest only insofar as they can be 
utilized to improve readiness and fire-fighting 

Unforeseeable Events 

So far we have dealt with diversification fore¬ 
casts based on what may be called foreseeable 
market conditions — conditions which we can 
interpret in terms of time-phased sales curves. 
Planners have a tendency to stop here, to disre¬ 
gard the fact that, in addition to the events for 
which we can draw time histories, there is a 
recognizable class of events to which we can 
assign a probability of occurrence but which we 
cannot otherwise describe in our present state 
of knowledge. One must move another notch 
up the scale of ignorance in order to consider 
these possibilities. 

Many businessmen feel that the effort is not 
worthwhile. They argue that since no informa¬ 
tion is available about these unforeseeable cir¬ 
cumstances, one might as well devote the avail¬ 
able time and energy to planning for the fore¬ 
seeable circumstances, or that, in a very general 
sense, planning for the foreseeable also prepares 
one for the unforeseeable contingencies. 

In contrast, more experienced military and 
business people have a very different attitude. 
Well aware of the importance and relative prob¬ 
ability of unforeseeable events, they ask why one 
should plan specific steps for the foreseeable 
events while neglecting the really important pos¬ 
sibilities. They may substitute for such plan¬ 
ning practical maxims for conducting one’s busi¬ 
ness — “be solvent,” “be light on your feet,” “be 
flexible.” Unfortunately, it is not always clear 

118 Harvard Business Review 

proved position in their own industry may be 
identified as companies that are notable for dras¬ 
tic changes made in their product mix and meth¬ 
ods, generating or responding to new competition. 

“There are two outstanding cases in which the 
industry leader of 1909 had by 1948 risen in 
position relative to its own industry group and also 
in rank among the 100 largest — one in chemicals 
and the other in electrical equipment. These two 
(General Electric and DuPont) are hardly recog¬ 
nizable as the same companies they were in 1909 
except for retention of the name; for in each case 
the product mix of 1948 is vastly different from 
what it was in the earlier year, and the markets 
in which the companies meet competition are in¬ 
comparably broader than those that accounted for 
their earlier place at the top of their industries. 
They exemplify the flux in the market positions 
of the most successful industrial giants during 
the past four decades and a general growth rather 
than a consolidation of supremacy in a circum¬ 
scribed line.” 4 

This suggests that the existence of specific 
undesirable trends is not the only reason for di¬ 
versification. A broader product line may be 
called for even with optimistic forecasts for pres¬ 
ent products. An examination of the foresee¬ 
able alternatives should be accompanied by an 
analysis of how well the over-all company prod¬ 
uct-market strategy covers the so-called growth 
areas of technology — areas of many potential 
discoveries. If such analysis shows that, because 
of its product lines, a company’s chances of tak¬ 
ing advantage of important discoveries are lim¬ 
ited, management should broaden its technolog¬ 
ical and economic base by entering a number of 
so-called “growth industries.” Even if the de¬ 
finable horizons look bright, a need for flexi¬ 
bility, in the widest sense of the word, may pro¬ 
vide potent reasons for diversification. 

Diversification Objectives 

If an analysis of trends and contingencies in¬ 
dicates that a company should diversify, where 
should it look for diversification opportunities? 

Generally speaking, there are three types of 

(1) Each product manufactured by a company 
is made up of functional components, parts, and 
basic materials which go into the final assembly. 
A manufacturing concern usually buys a large 
fraction of these from outside suppliers. One way 

* Ibid., p. 142. 

to diversify, commonly known as vertical diversifi¬ 
cation, is to branch out into production of com¬ 
ponents, parts, and materials. Perhaps the most 
outstanding example of vertical diversification is 
the Ford empire in the days of Henry Ford, Sr. 

At first glance, vertical diversification seems in¬ 
consistent with our definition of a diversification 
strategy. However, the respective missions which 
components, parts, and materials are designed to 
perform are distinct from the mission of the over¬ 
all product. Furthermore, the technology in fabri¬ 
cation and manufacture of these parts and materials 
is likely to be very different from the technology 
of manufacturing the final product. Thus, vertical 
diversification does imply both catering to new 
missions and introduction of new products. 

(2) Another possible way to go is horizontal di¬ 
versification. This can be described as the intro¬ 
duction of new products which, while they do not 
contribute to the present product fine in any way, 
cater to missions which lie within the company’s 
know-how and experience in technology, finance, 
and marketing. 

( 3 ) It is also possible, by lateral diversification, 
to move beyond the confines of the industry to 
which a company belongs. This obviously opens 
a great many possibilities, from operating banana 
boats to building atomic reactors. While vertical 
and horizontal diversification are restrictive, in the 
sense that they delimit the field of interest, lateral 
diversification is “wide open.” It is an announce¬ 
ment of the company’s intent to range far afield 
from its present market structure. 

Choice of Direction 

How does a company choose among these di¬ 
versification directions? In part the answer de¬ 
pends on the reasons which prompt diversifica¬ 
tion. For example, in the light of the trends de¬ 
scribed for the industry, an aircraft company 
may make the following moves to meet long- 
range sales objectives through diversification: 

1 . A vertical move to contribute to the techno¬ 
logical progress of the present product line. 

2. A horizontal move to improve the coverage 
of the military market. 

3 . A horizontal move to increase the percen¬ 
tage of commercial sales in the over-all sales 

4 . A lateral move to stabilize sales in case of a 

5 . A lateral move to broaden the company’s 
technological base. 

Some of these diversification objectives apply 
to characteristics of the product, some to those 

Strategies for Diversification 117 

Exhibit iv. Changes in list of the ioo largest industrial corporations 

(even to the people who preach it) what this 
flexibility means. 

An interesting study by The Brookings Insti¬ 
tution 3 provides an example of the importance 
of the unforeseeable events to business. Ex¬ 
hibit iv shows the changing make-up of the 
list of the ioo largest corporations over the last 
50 years. Of the 100 largest on the 1909 list 
(represented by the heavy marble texture) only 
36 were among the 100 largest in 1948; just 
about half of the new entries to the list in 1919 
(represented by white) were left in 1948; less 
than half of the new entries in 1929 (repre¬ 
sented by the zigzag design) were left in 1948; 
and so on. Clearly, a majority of the giants of 
yesteryear have dropped behind in a relatively 
short span of time. 

Many of the events that hurt these corpora¬ 
tions could not be specifically foreseen in 1909. 
If the companies which dropped from the orig¬ 
inal list had made forecasts of the foreseeable 
kind at that time — and some of them must 
have — they would very likely have found the 
future growth prospects to be excellent. Since 
then, however, railroads, which loomed as the 

3 A. D. H. Kaplan, op. cit. 

primary means of transportation, have given 
way to the automobile and the airplane; the tex¬ 
tile industry, which appeared to have a built-in 
demand in an expanding world population, has 
been challenged and dominated by synthetics; 
radio, radar, and television have created means 
of communication unforeseeable in significance 
and scope; and many other sweeping changes 
have occurred. 

Planning for the Unknown 

The lessons of the past 50 years are fully ap¬ 
plicable today. The pace of economic and tech¬ 
nological change is so rapid that it is virtually 
certain that major breakthroughs comparable to 
those of the last 50 years, but not yet foreseeable 
in scope and character, will profoundly change 
the structure of the national economy. All of 
this has important implications for diversifica¬ 
tion, as suggested by the Brookings study: 

“The majority of the companies included among 
the 100 largest of our day have attained their posi¬ 
tions within the last two decades. They are com¬ 
panies that have started new industries or have 
transformed old ones to create or meet consumer 
preferences. The companies that have not only 
grown in absolute terms but have gained an im- 

of the product missions. Each objective is de¬ 
signed to improve some aspect of the balance 
between the over-all product-market strategy and 
the expected environment. The specific objec¬ 
tives derived for any given case can be grouped 
into three general categories: growth objectives, 
such as i, 2, and 3 above, which are designed 
to improve the balance under favorable trend 
conditions; stability objectives, such as 3 and 4, 
designed as protection against unfavorable 
trends and foreseeable contingencies; and flexi¬ 
bility objectives, such as 5, to strengthen the 
company against unforeseeable contingencies. 

A diversification direction which is highly de¬ 
sirable for one of the objectives is likely to be 
less desirable for others. For example: 

€ If a company is diversifying because its sales 
trend shows a declining volume of demand, it 
would be unwise to consider vertical diversification, 
since this would be at best a temporary device to 
stave off an eventual decline of business. 

C If a company’s industry shows every sign of 
healthy growth, then vertical and, in particular, 
horizontal diversification would be a desirable de¬ 
vice for strengthening the position of the com¬ 
pany in a field in which its knowledge and ex¬ 
perience are concentrated. 

C If the major concern is stability under a con¬ 
tingent forecast, chances are that both horizontal 
and vertical diversification could not provide a suf¬ 
ficient stabilizing influence and that lateral action 
is called for. 

C If management’s concern is with the narrow¬ 
ness of the technological base in the face of what 
we have called unforeseeable contingencies, then 
lateral diversification into new areas of technology 
would be clearly indicated. 

Measured Sales Goals 

Management can and should state the objec¬ 
tives of growth and stability in quantitative 
terms as long-range sales objectives. This is il¬ 
lustrated in Exhibit v. The solid lines describe 
a hypothetical company’s forecasted perform¬ 
ance without diversification under a general 
trend, represented by the sales curve marked S 1; 
and in a contingency, represented by S 2 . The 
dashed lines show the improved performance as 
a result of diversification, with S 3 representing 
the curve for continuation of normal trends and 
S 4 representing the curve for a major reverse. 

Growth. Management’s first aim in diversify¬ 
ing is to improve the growth pattern of the com¬ 
pany. The growth objective can be stated thus: 

Strategies for Diversification 119 

Under trend conditions the growth rate of sales 
after diversification should exceed the growth rate 
of sales of the original product line by a minimum 
specified margin. Or to illustrate in mathematical 
shorthand, the objective for the company in Ex¬ 
hibit v would be: 

S3 — Si ^ p 

where the value of the margin p is specified for 
each year after diversification. 

Exhibit v. Diversification objectives 



Some companies (particularly in the growth 
industries) fix an annual rate of growth which 
they wish to attain. Every year this rate of 
growth is compared to the actual growth during 
the past year. A decision on diversification ac¬ 
tion for the coming year is then based upon the 
disparity between the objective and the actual 
rate of growth. 

Stability. The second effect desired of diver¬ 
sification is improvement in company stability 
under contingent conditions. Not only should 
diversification prevent sales from dropping as 
low as they might have before diversification, 
but the percentage drop should also be lower. 
The second sales objective is thus a stability ob¬ 
jective. It can be stated as follows: 

Under contingent conditions the percentage de¬ 
cline in sales which may occur without diversifica¬ 
tion should exceed the percentage drop in sales 
with diversification by an adequate margin, or 

Si — S2 S3 — S4 

--- >5 

Si S3 

Using this equation, it is possible to relate 
the sales volumes before and after diversifica¬ 
tion to a rough measure of the resulting stability. 
Let the ratio of the lowest sales during a slump 
to the sales which would have occurred in the 
same year under trend conditions be called the 
stability factor F. Thus, F = 0.3 would mean 
that the company sales during a contingency 

120 Harvard Business Review 

amount to 30% of what is expected under trend 
conditions. In Exhibit vi the stability factor of 
the company before diversification is the value 
Fj. = Sg/Sx and the stability factor after diver¬ 
sification is F 3 = S4/S3, both computed at the 
point on the curve where S 2 is minimum. 

Now let us suppose that management is con¬ 
sidering the purchase of a subsidiary. How 
large does the subsidiary have to be if the parent 
is to improve the stability of the corporation as 
a whole by a certain amount? Exhibit vi shows 
how the question can be answered: 

On the horizontal axis we plot the different 
possible sales volumes of a smaller firm that might 
be secured as a proportion of the parent’s volume. 
Obviously, the greater this proportion, the greater 
the impact of the purchase on the parent’s stability. 

On the vertical axis we plot different ratios of 
the parent’s stability before and after diversifica¬ 
tion (F3/F1). 

The assumed stability factor of the parent is 
0.3. Let us say that four prospective subsidiaries 
have stability factors of 1.0, 0.9, 0.75, and 0.6. 
If they were not considerably higher than 0.3, of 
course, there would be no point in acquiring them 
(at least for our purposes here). 

Exhibit vi. Improvement in stability factor 



On the graph we correlate these four stability 
factors of the subsidiary with (i) the ratio F 3 /Fi 
and (2) different sales volumes of the subsidiary. 
We find, for example, that if the parent is to 
double its stability (point 2.0 on the vertical axis), 
it must obtain a subsidiary with a stability of 1.0 
and 75% as much sales volume as the parent, or 
a subsidiary with a stability of 0.9 and 95% of the 
sales volume. If the parent seeks an improvement 
in stability of, say, only 40%, it could buy a 
company with a stability of 0.9 and 25% as much 
sales volume as it has. 

This particular way of expressing sales ob¬ 
jectives has two important advantages: (1) By 

setting minimum, rather than maximum, limits 
on growth, it leaves room for the company to 
take advantage of unusual growth opportunities 
in order to exceed these goals, and thus provides 
definite goals without inhibiting initiative and 
incentive. (2) It takes account of the time¬ 
phasing of diversification moves; and since these 
moves invariably require a transition period, the 
numerical values of growth objectives can be 
allowed to vary from year to year so as to allow 
for a gradual development of operations. 

Long-Range Objectives 

Diversification objectives specify directions 
in which a company’s product-market should 
change. Usually there will be several objectives 
indicating different and sometimes conflicting 
directions. If a company attempts to follow all 
of them simultaneously, it is in danger of spread¬ 
ing itself too thin and of becoming a conglom¬ 
eration of incompatible, although perhaps indi¬ 
vidually profitable, enterprises. 

There are cases of diversification which have 
followed this path. In a majority of cases, how¬ 
ever, there are valid reasons why a company 
should seek to preserve certain basic unifying 
characteristics as it goes through a process of 
growth and change. Consequently, diversifica¬ 
tion objectives should be supplemented by a 
statement of long-range product-market objec¬ 
tives. For instance: 

C One consistent course of action is to adopt a 
product-market policy which will preserve a kind 
of technological coherence among the different 
manufactures with the focus on the products of 
the parent company. For instance, a company 
that is mainly distinguished for a type of engi¬ 
neering and production excellence would continue 
to select product-market entries which would 
strengthen and maintain this excellence. Perhaps 
the best known example of such policy is exempli¬ 
fied by the DuPont slogan, “Better things for 
better living through chemistry.” 

C Another approach is to set long-term growth 
policy in terms of the breadth of market which 
the company intends to cover. It may choose to 
confine its diversifications to the vertical or hori¬ 
zontal direction, or it may select a type of lateral 
diversification controlled by the characteristics of 
the missions to which the company intends to 
cater. For example, a company in the field of air 
transportation may expand its interest to all forms 
of transportation of people and cargo. To para¬ 
phrase DuPont, some slogan like “Better trans- 

portation for better living through advanced en¬ 
gineering,” would be descriptive of such a long- 
range policy. 

C A greatly different policy is to emphasize pri¬ 
marily the financial characteristics of the corpo¬ 
ration. This method of diversification generally 
places no limits on engineering and manufacturing 
characteristics of new products, although in prac¬ 
tice the competence and interests of management 
will usually provide some orientation for diversifi¬ 
cation moves. The company makes the decisions 
regarding the distribution of new acquisitions ex¬ 
clusively on the basis of financial considerations. 
Rather than a manufacturing entity, the corporate 
character is now one of a “holding company.” Top 
management delegates a large share of its product¬ 
planning and administrative functions to the divi¬ 
sions and concerns itself largely with coordination, 
financial problems, and with building up a bal¬ 
anced “portfolio of products” within the corporate 

Successful Alternatives 

These alternative long-range policies demon¬ 
strate the extremes. No one course is necessar¬ 
ily better than the others; management’s choice 
will rest in large part on its preferences, ob¬ 
jectives, skills, and training. The aircraft in¬ 
dustry illustrates the fact that there is more than 
one successful path to diversification: 

C Among the major successful airframe manu¬ 
facturers, Douglas Aircraft Company, Inc., and 
Boeing Airplane Company have to date limited 
their growth to horizontal diversification into mis¬ 
siles and new markets for new types of aircraft. 
Lockheed has carried horizontal diversification fur¬ 
ther to include aircraft maintenance, aircraft serv¬ 
ice, and production of ground-handling equipment. 

C North American Aviation, Incorporated, on 
the other hand, appears to have chosen vertical 
diversification by establishing its subsidiaries in 
Atomics International, Autonetics, and Rocketdyne, 
thus providing a basis for manufacture of com¬ 
plete air vehicles of the future. 

« Bell Aircraft Corporation has adopted a policy 
of technological consistency among the items in 
its product line. It has diversified laterally but pri¬ 
marily into types of products for which it had pre¬ 
vious know-how and experience. 

® General Dynamics Corporation provides a fur¬ 
ther interesting contrast. It has gone far into lat¬ 
eral diversification. Among the major manufac¬ 
turers of air vehicles, it comes closest to the “hold¬ 
ing company” extreme. Its airplanes and missile 
manufacturing operations in Convair are paralleled 
by production of submarines in the Electric Boat 

Strategies for Diversification 121 

Division; military, industrial, and consumer elec¬ 
tronic products in the Stromberg-Carlson Division; 
electric motors in the Electro Dynamic Division. 

Selecting a Strategy 

In the preceding sections qualitative criteria 
for diversification have been discussed. How 
should management apply these criteria to in¬ 
dividual opportunities? Two steps should be 
taken: (i) apply the qualitative standards to 
narrow the field of diversification opportunities; 
(2) apply the numerical criteria to select the 
preferred strategy or strategies, 

Qualitative Evaluation 

The long-range product-market policy is used 
as a criterion for the first rough cut in the quali¬ 
tative evaluation. It can be used to divide a large 
field of opportunities into classes of diversifica¬ 
tion moves consistent with the company’s basic 
character. For example, a company whose policy 
is to compete on the basis of the technical ex¬ 
cellence of its products would eliminate as in¬ 
consistent classes of consumer products which 
are sold on the strength of advertising appeal 
rather than superior quality. 

Next, the company can compare each indi¬ 
vidual diversification opportunity with the in¬ 
dividual diversification objectives. This process 
tends to eliminate opportunities which, while 
still consistent with the desired product-market 
make-up, are nevertheless likely to lead to an 
imbalance between the company product line 
and the probable environment. For example, a 
company which wishes to preserve and expand 
its technical exellence in design of large, highly 
stressed machines controlled by feedback tech¬ 
niques may find consistent product opportunities 
both inside and outside the industry to which it 
eaters, but if one of its major diversification ob¬ 
jectives is to correct cyclic variations in demand 
that are characteristic of the industry, it would 
choose an opportunity that lies outside. 

Each diversification opportunity which has 
gone through the two screening steps satisfies at 
least one diversification objective, but probably 
it will not satisfy all of them. Therefore, before 
subjecting them to the quantitative evaluation, 
it is necessary to group them into several alterna¬ 
tive over-all company product-market strategies, 
composed of the original strategy and one or 
more of the remaining diversification strategies. 
These alternative over-all strategies should be 

122 Harvard Business Review 

roughly equivalent in meeting all of the diver¬ 
sification objectives. 

At this stage it is particularly important to 
allow for the unforeseeable contingencies. Since 
the techniques of numerical evaluation are ap¬ 
plicable only to trends and foreseeable contin¬ 
gencies, it is important to make sure that the 
different alternatives chosen give the company 
a broad enough technological base. In practice 
this process is less formidable than it may ap¬ 
pear. For example, a company in the aircraft 
industry has to consider the areas of technology 
in which major discoveries are likely to affect 
the future of the industry. This would include 
atomic propulsion, certain areas of electronics, 
automation of complex processes, and so forth. 
In designing alternative over-all strategies the 
company would then make sure that each con¬ 
tains product entries which will give the firm 
a desirable and comparable degree of participa¬ 
tion in these future growth areas. 

Quantitative Evaluation 

Will the company’s product-market strategies 
make money? Will the profit structure improve 
as a result of their adoption? The purpose of 
quantitative evaluation is to compare the profit 
potential of the alternatives. 

Unfortunately, there is no single yardstick 
among those commonly used in business that 
gives an accurate measurement of performance. 
The techniques currently used for measurement 
of business performance constitute, at best, an 
imprecise art. It is common to measure differ¬ 
ent aspects of performance by applying different 
tests. Thus, tests of income adequacy measure 
the earning ability of the business; tests of debt 
coverage and liquidity measure preparedness 
for contingencies; the shareholders’ position 
measures attractiveness to investors; tests of 
sales efficiency and personnel productivity meas-. 
ure efficiency in the use of money, physical 
assets, and personnel. These tests employ a va¬ 
riety of different performance ratios, such as re¬ 
turn on sales, return on net worth, return on 
assets, turnover of net worth, and ratio of assets 
to liabilities. The total number of ratios may run 
as high as 20 in a single case. 

In the final evaluation, which immediately 
precedes a diversification decision, management 
would normally apply all of these tests, tem¬ 
pered with business judgment. However, for 
the purpose of preliminary elimination of al¬ 
ternatives, a single test is frequently used — 

return on investment, a ratio between earnings 
and the capital invested in producing these earn¬ 
ings. While the usefulness of return on invest¬ 
ment is commonly accepted, there is consider¬ 
able room for argument regarding its limitations 
and its practical application. 5 Fundamentally, 
the difficulty with the concept is that it fails to 
provide an absolute measure of business per¬ 
formance applicable to a range of very different 
industries; also, the term “investment” is sub¬ 
ject to a variety of interpretations. 

But, since our aim is to use the concept as a 
measure of relative performance of different di¬ 
versification strategies, we need not be con¬ 
cerned with its failure to measure absolute 
values. And as long as we are consistent in our 
definition of investment in alternative courses 
of action, the question of terminology is not so 
troublesome. We cannot define profit-produc¬ 
ing capital in general terms, but we can define 
it in each case in the light of particular business 
characteristics and practices (such as the extent 
of government-owned assets, depreciation prac¬ 
tices, inflationary trends). 

For the numerator of our return on invest¬ 
ment, we can use net earnings after taxes. A 
going business concern has standard techniques 
for estimating its future earnings. These de¬ 
pend on the projected sales volume, tax struc¬ 
ture, trends in material and labor costs, produc¬ 
tivity, and so forth. If the diversification oppor¬ 
tunity being considered is itself a going concern, 
its profit projections can be used for estimates of 
combined future earnings. If the opportunity 
is a new venture, its profit estimates should be 
made on the basis of the average performance 
for the industry. 

Changes in Investment Structure 

A change in the investment structure of the 
diversifying company accompanies a diversifica¬ 
tion move. The source of investment for the 
new venture may be: (1) excess capital, (2) cap¬ 
ital borrowed at an attractive rate, (3) .an ex¬ 
change of the company’s equity for an equity in 
another company, or (4) capital withdrawn from 
present business operations. 

If we let b, i 2 , i 3 , and i 4 , respectively, repre- 

5 See Charles R. Schwartz, The Return-on-Investment 
Concept as a Tool for Decision Making, General Manage¬ 
ment Series No. 183 (New York, American Management 
Association, 1956), pp. 42-61; Peter F. Drueker, The 
Practice of Management (New York, Harper & Brothers, 
1954); and Edward M. Barnet, “Showdown in the Mar¬ 
ket Place,” HBR July-August 1956, p. 85. 

sent investments made in the new product in 
the preceding four categories during the first 
year of diversified operations, we can derive a 
simple expression for the improvement in return 
on investment resulting from diversification: 

AR=(p 2 -p 1 )(i 3 4-i3+i < )+(p2-r) ii-hr-KPi-rXM-iQii/I 

I + i 2 +i 3 

where p x and p 2 represent the average return 
on capital invested in the original product and 
in the new product, respectively, and quantity 
I is the total capital in the business before 

We can easily check this expression by assum¬ 
ing that only one type of new investment will be 
made at a time. We can then use the formula to 
compute the conditions under which it pays to 
diversify (that is, conditions where AR is greater 
than zero): 

( 1 ) If excess capital is the only source of new 
investment (i 2 = i 3 = i 4 = o), this condition is 
p 2 — r > o, That is, return on diversified opera¬ 
tions should he more attractive than current rates 
for capital on the open market. 

( 2 ) If only borrowed capital is used (ii = i 3 = 
4 = o), it pays to diversify if p 2 — pi > r. That 
is, the difference between return from diversifica¬ 
tion and return from the original product should 
be greater than the interest rate on the money. 

( 3 ) If the diversified operation is to be ac¬ 
quired through an exchange of equity or through 
internal reallocation of capital, p 2 — Pi > o is the 
condition under which diversification will pay off. 

A Comprehensive Yardstick 

The formula for AR just stated is not suffi¬ 
ciently general to serve as a measure of profit 
potential. It gives improvement in return for 
the first year only and for a particular sales 
trend. In order to provide a reasonably compre¬ 
hensive comparison between alternative over-all 
company strategies, the yardstick for profit po¬ 
tential should possess the following properties: 

( 1 ) Since changes in the investment structure 
of the business invariably accompany diversifica¬ 
tion, the yardstick should reflect these changes. 
It should also take explicit account of new capital 
brought into the business and changes in the rate 
of capital formation resulting from diversification, 
as well as costs of borrowed capital. 

( 2 ) Usually the combined performance of the 
new and the old product-market lines is not a sim¬ 
ple sum of their separate performances; it should 

° See H. Igor Ansoff, A Model for Diversification (Bur¬ 
bank, Lockheed Aircraft Corporation, 1957); and John 

Strategies for Diversification 123 

be greater. The profit potential yardstick must 
take account of this nonlinear characteristic. 

( 3 ) Each diversification move is characterized 
by a transition period during which readjustment 
of the company structure to new operating condi¬ 
tions takes place. The benefits of a diversification 
move may not be realized fully for some time, so 
the measurement of profit potential should span a 
sufficient length of time to allow for effects of the 

( 4 ) Since both profits and investments will be 
spread over time, the yardstick should use their 
present value. 

( 5 ) Business performance will differ depend¬ 
ing on the particular economic-political environ¬ 
ment. The profit potential yardstick must some¬ 
how average out the probable effect of alternative 

(6) The statement of sales objectives, as pointed 
out previously, should specify the general charac¬ 
teristics of growth and stability which are desired. 
Profit potential functions should be compatible 
with these characteristics. 

We can generalize our formula in a way 
which will meet most of the preceding require¬ 
ments. The procedure is to write an expression 
for the present value of AR for an arbitrary year, 
t, allowing for possible yearly diversification in¬ 
vestments up to the year t, interest rates, and 
the rate of capital formation. Then this present 
value is averaged over time as well as over the 
alternative sales forecasts. The procedure is 
straightforward (although the alegebra involved 
is too cumbersome to be worth reproducing 
here 6 ). The result, which is the “average ex¬ 
pected present value of AR,” takes account of 
conditions (i) through (5), above. Let us call 
it (AR) e . It can be computed using data nor¬ 
mally found in business and financial forecasts. 

Final Evaluation 

This brings us to the final step in the evalua¬ 
tion. We have discussed a qualitative method 
for constructing several over-all product-market 
strategies which meet the diversification and the 
long-range objectives. We can now compute 
(AR) e for each of the over-all strategies and, at 
the same time, make sure that the strategies 
satisfy the sales objectives previously stated, thus 
fulfilling condition (6), above. 

If product-market characteristics, which we 
have used to narrow the field of choice and to 
compute (AR) e , were the sole criteria, then the 

Burr Williams, The Theory of Investment Value (Am¬ 
sterdam, The North-Holland Publishing Co., 1938). 

124 Harvard Business Review 

strategy with the highest (AR) e would be the 
“preferred” path to diversification. The advan¬ 
tages of a particular product-market opportunity, 
however, must be balanced against the chances 
of business success. 


A study of diversification histories shows that 
a firm usually arrives at a decision to make a 
particular move through a multistep process. 
The planners’ first step is to determine the pre¬ 
ferred areas for search; the second is to select a 
number of diversification opportunities within 
these areas and to subject them to a preliminary 
evaluation. They then make a final evaluation, 
conducted by the top management, leading to 
selection of a specific step; finally, they work 
out details and complete the move. 

Throughout this process, the company seeks 
to answer two basic questions: How well will a 
particular move, if it is successful, meet the 
company’s objectives? What are the company’s 
chances of making it a success? In the early 
stages of the program, the major concern is with 
business strategy. Hence, the first question plays 
a dominant role. But as the choice narrows, 
considerations of business ability, of the particu¬ 
lar strengths and weaknesses which a company 
brings to diversification, shift attention to the 
second question. 

This discussion has been devoted primarily to 
selection of a diversification strategy. We have 
dealt with what may be called external aspects 
of diversification — the relation between a com¬ 
pany and its environment. To put it. another 
way, we have derived a method for measuring 
the profit potential of a diversification strategy, 
but we have not inquired into the internal fac¬ 
tors which determine the ability of a diversifying 
company to make good this potential. A com¬ 
pany planning diversification must consider such 
questions as how the company should organize 
to conduct the search for and evaluation of 
diversification opportunities; what method of 
business expansion it should employ; and how 
it should mesh its operations with those of a sub¬ 
sidiary. These considerations give rise to a new 
set of criteria for the business fit of the prospec¬ 
tive venture. These must be used in conjunc¬ 
tion with (AR) e as computed in the preceding 
section to determine which of the over-all prod¬ 
uct-market strategies should be selected for 

Thus, the steps outlined in this article are 
the first, though an important, preliminary to a 
diversification move. Only through further care¬ 
ful consideration of probable business success 
can a company develop a long-range strategy that 
will enable it to “run twice as fast as that” (using 
the Red Queen’s words again) in the ever-chang¬ 
ing world of today. 

I n a highly diversified company . . . there is a natural tendency to 
assign a single executive the responsibility for so many diverse businesses 
that he becomes a jack of all trades and a master of none. . ... 

This is serious, because American business competition no longer per¬ 
mits survival of businesses without managers of special intelligence and 
competence in their individual fields. Therefore, as a continuing process, 
we attempt to organize our company [W. R. Grace & Co.] so that the 
manager for any business or group of businesses is as expert in them as his 
competition. This is sometimes difficult. As one important aid, we have 
tried to minimize the number of management levels; we have tried to keep 
the organization “flat.” The more management levels you have, we 
feel, the more friction, inertia and slack you have to overcome, and the 
greater the distortion of objectives and the misdirection of attention. In 
this you must always be on your guard, because levels of management, 
like tree rings, grow with age. As one company president put it, “If all an 
executive does is agree with his subordinate executive, you don’t need both 
of them.” 

Ernest C. Arbuckle, "Diversification,” Management for Growth, edited by 
Gayton E. Germane 

Stanford University, Graduate School of Business, 1957, pp. 85-86.